Eiger's Assessment and Economic Forecast
Despite Halloween-worthy (scary) news about inflation and other aspects of the economy, we continue to be optimistic about our diversified investment approach. Let us discuss hoarding, metal cubes, and cigarettes, among other items, to assess the state of the investment world.
At the beginning of COVID, we saw complaints about people hoarding supplies. After all, hoarders just increased the growing supply shortages. But if businesses had been better at stockpiling, we likely wouldn’t have today’s inflation concerns.
Maintaining inventories is expensive. Consequently, many businesses reduced their storage capacity over the years. With an increasingly efficient shipping industry, stockpiling assets became more and more pointless. But that all changed during COVID. With a labor and production shortage, and other disruptions to the supply chain, businesses quickly ran out of material.
An industry particularly hard hit by supply chain shortages is the car industry. Besides chip shortages, car manufacturers face a looming magnesium shortage. Why is that a problem you may ask? Magnesium is essential in the production of aluminum—a key ingredient of car making. Europe, for example, collects 95% of its magnesium from China. In order to preserve energy, China shut off more than half of its magnesium production. The remaining production is running at half capacity. Predictions have Europe running out of magnesium before the end of the year.
Rental car companies started selling their idle fleets in 2020 to save storage costs. Now they struggle to meet the growing demand for rental cars as Americans resume pent-up travel plans. Add the supply shortage to the increased demand and prices are pushed higher and higher. Used cars are selling at record prices.
In order to keep prices of goods low, keeping inventories as small as possible is essential. But with a supply chain disruption, prices rise until the supply chain is fixed. Once the delayed orders for goods arrive, we may end up with another problem if businesses are now overstocked. Inflation would quickly disappear and deflation could become a concern. But the more likely scenario is a return to acceptable levels of inflation.
What makes the current situation unpredictable is that we encountered the perfect storm. Companies kept little inventory. They struggle with not enough labor to handle production and shipment. Demand is growing. Then you add other hiccups like the freighter that got stuck in the Suez Canal and blocked passage for six days earlier this year, and natural catastrophes. Add government intervention to it and predicting what will happen becomes impossible. Then mix in the following ingredients to the economic meal:
General labor shortage
Soaring energy prices
Surge in COVID-19 Delta variant cases
End of enhanced US unemployment benefits
Disagreements over pending infrastructure bill
Widespread political deadlock and a split nation
Hasty U.S. withdrawal from Afghanistan
Stocks at all-time highs
Unattractive bond rates
Social media driven trading
No wonder cigarette sales increased in 2020 for the first time in 20 years. Looking for new ways to invest and stay entertained, younger investors are experimenting with novel investments like NFTs and tungsten cubes (not to mention the never-ending supply of innovative crypto currencies). Indecision and confusion rise. Alta Capital Management, a stock manager, published the following statement in their most recent commentary:
The world has never experienced the conditions which have prevailed over the last 18 months and the uncomfortable reality is that nobody knows exactly how things will play out... History isn’t much of a guide at the moment. Most prognostications are about as good as astrological predictions.
Despite the challenges, our crystal ball predicts continued, though muted, economic growth. Inflation concerns will likely fade within the next two years. Stagflation will not materialize (at least not for several years). Short-term interest rates in the US will stay close to zero through 2022. Long-term interest rates will rise slightly. Volatility in the stock market will increase. Maintaining past returns will likely require increased risk-taking. Periodic drops in stock values will offer buying opportunities. Other opportunities are still available in the following areas:
Infrastructure, as the government seeks to improve and expand transportation, clean energy, and access to wireless technologies
Private credit, which is typically structured with a floating rate and is therefore less sensitive to rising interest rates
Distressed debt and real estate, which are harder to come by in the current markets that are frothy with liquidity, but can be found in niche sectors, such as hospitality, or merely on an asset-by-asset basis.
We are guardedly optimistic for the foreseeable future and look forward to a gradual return to “normal.” As always, we’re happy to discuss your personal situation and explore any changes you may want to implement.